Why China’s Economic Growth is More Bark Than Bite

Carl Delfeld writes: Is the great Chinese locomotive destined to run off the rails?

It is, according to renowned short-seller, Jim Chanos.

But is he right this time? After all, as recently as 1990, China’s GDP was roughly equal to that of Taiwan. Today, it’s 10 times bigger. And there’s no question that the country’s incredible growth story has pulled many millions from poverty.

I must admit that I’m sympathetic to China skeptics like Chanos. Why? Let’s dig in and I’ll show you why the China hype is overblown…

Three Factors That Could Slow Chinese Economic Growth

Allow me to throw some eye-opening statistics your way…

•Industrial Growth
Already into its 13th year, China’s investment-led industrial growth is now very long in the tooth. Research by Pivot Capital Management shows that the longest previous period of investment-led economic growth was nine years (in Thailand and Singapore). But China’s real fixed investment has increased at a faster rate than GDP in nine of the past 10 years.

Investment is at 70% of GDP and the return on every marginal dollar invested in China is decreasing. In 2000, it took $1.50 of credit to generate $1 of GDP. But by 2008, it took $7 of new credit to generate a $1 increase in GDP.

China’s bank lending explosion has led to credit-to-GDP rising to 140% – levels equal to America in 2008 and Japan in 1991 just before their market meltdowns.

•Overheating Economy
That heavy investment has led to substantial overcapacity in China’s manufacturing, real estate and infrastructure, as well as deteriorating credit quality and weakening export markets.

Examples of China’s overcapacity include its steel industry, which is equal to that of America, Japan, Russia and the 27 European Union countries put together. And its aluminum capacity is eight times larger than America on a per capita basis.

•Politics
China’s brittle political system makes the chances of adjusting to consumer-led economic growth remote at best.

The end result? These factors will lead to a growth rate far below what the markets expect. In turn, that will lead to a China crisis, which will only accelerate as the global macro picture shines the spotlight on China’s shrinking export markets and industrial overcapacity.

I’m not the only one who thinks so…

You Think U.S. Unemployment is Bad? Try China…

“There are worrisome signs that China just doesn’t get it, that it’s clinging to antiquated policy and economic growth strategies that pre-suppose a classic snapback in global demand.”

So says Stephen Roach in The Next Asia.

Since the Communist Party bases its legitimacy largely on producing high levels of economic growth and employment, internal pressures and sharp divisions on how to deal with the slowdown within the party will emerge. Analysts already believe that unemployment is over 10% – and will worsen to uncomfortable levels.

China Losing its Competitive Price Advantage

China’s role as a low cost base for global manufacturing is also less compelling, given the logistical issues associated with the supply lines spanning the Pacific.

Apix Partners studied five manufacturing segments over a five-year period and found that China’s pricing advantage for goods arriving in California, relative to domestic prices, has declined from 22% to just 5.5%.

And then there’s the issue of China’s queasy public finances. Can you say “debt bubble?”

Following America and Western Europe Down the Debt Trail

Pivot’s research shows that rather than China having a manageable public debt-to-GDP ratio of 35%, the inclusion of off balance sheet items like local government bond guarantees brings this number closer to an uncomfortable 62%.

In addition, China’s non-performing loan data is clearly being managed, as it doesn’t include the $200 billion worth of bad loans from China’s top four state-owned banks that were moved “off balance sheet” to state-run asset management companies.

This expansion in state-owned bank lending power should also dampen hopes that China will turn more control and ownership over to private capital and management. For proof, look no further than China’s 10 largest companies, which are all state-owned or controlled, as are 34 of the top 35 companies on the Shanghai exchange.

So could China fulfill bold predictions that label it the long-term growth story of the century? Perhaps. But a closer look behind the headlines is enough to raise doubts about the sustainability of China’s economic growth, as noted by investors like Jim Chanos.

And when it sinks in that China, rather than a provider of global growth, is actually in the same slow-growth/high debt boat as America and Western Europe – and without durable political institutions – all bets will be off.

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